“6 Reasons Why a Protective Collar is the Perfect Strategy Since 2007”
The recent bull market began on March 6, 2009 and has provided staggering returns to patient investors.
At the time of this writing, the cap-weighted S&P 500 (symbol: SPX) rallied +195.50%, the Dow Jones Average
(symbol: DJIA) +162.25%, and the Guggenheim Equal Weighted S&P 500 (symbol: RSP) is +277.00% higher. (1)
Shareholders and corporate insiders with a substantial amount of net worth tied up in company stock may want to raise cash and reduce risk to their portfolio. Nobody wants to see his or her net worth evaporate as it happened in 2000- 2001 and 2007-2008. Investors may want to monitor what insiders are doing, since stock transactions are public information. (2)
Corporate insiders must complete SEC Form 4, within two business days of effecting a stock transaction. (3)
However, if the company shares have listed options and there is a reasonable amount of activity in the options, a protective collar strategy just might be the best solution since 2007 for shareholders with large quantities of company stock. (4)
Benefits of a Protective Collar strategy include:
- Insure against crippling portfolio losses by purchasing a downside “put” option
- Increase the static yield potential by skewing the credit generated from the sale of the call
- Maintain shareholder-voting rights. A collar doesn’t reduce the number of shares you own
- Liquidity is available since you can quickly borrow cash against the value of the account value if needed
- Delay taxable gains because stock ownership is still maintained; you’ve only temporarily hedged the position
- Dividend income stream is completely uninterrupted until you decide to sell shares
Experience teaches us that there is no free lunch on Wall Street. The disadvantages of a collar strategy include:
- Upside profit participation is limited and pre-defined by the symmetry of the strike prices chosen
- Creation of a taxable event if shares are assigned, or “called” away unexpectedly
Professional option traders view the collar strategy as protective; since it is designed to reduce downside losses while simultaneously capping upside potential. Upside growth and participation is achieved by reducing the number of equity collars in place.
The equity collar strategy isn’t right for everyone, but it can buy an investor some valuable time while stocks are expected to take a rest and digest the fabulous gains enjoyed over the last six years.
Bill Ulivieri is the owner of Cenacle Capital Management, (CCM) an Illinois State registered investment advisor. CCM is a separate account portfolio manager and Bill has over 30 years’ experience. www.cenaclecapital.com.
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(1) 1/19/2015: The returns for indexes, ETFs, futures, and stocks do not reflect dividends and are based on the last sale for the date requested. Returns for mutual funds do account for distributions. Performance data does not include all transaction costs. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.
Prior to buying or selling an option, investors must read a copy of the Characteristics & Risks of Standardized Options, also known as the options disclosure document (ODD). It explains the characteristics and risks of exchange traded options. http://www.optionsclearing.com/about/publications/publication-listing.jsp
(2) insidertrading.org/
(3) www.sec.gov/investor/alerts/forms-3-4-5.pdf
(4) www.cboe.com/strategies/equityoptions/equitycollars/part1.aspx